A tutorial for understanding your pension plan

Public pension plans are the biggest source of retirement income for the average Canadians. That’s the CPP (Canada Pension Plan) and OAS (Old Age Security). Our second largest income source is employer pension plans.

Employer Pension Plans

Five million Canadians belong to an employer-sponsored pension plan. The problem is many of them have little idea of the kind of plan they have, how it works and how much income it will provide. It’s a grave mistake to pay so little attention to such an important source of retirement income. There are two kinds of pension plans: defined-benefit (DB) and defined-contribution (DC).

Defined Benefit Pension Plans

Defined Benefit Pension Plans, unfortunately, are becoming rare. Benefits are guaranteed, as long as the plan remains viable and fully funded. The guaranteed income is great for plan members but DB plans are expensive for employers, which is why they’re going the way of the dodo bird and Toronto Maple Leafs’ Stanley Cup wins.

Defined Contribution Pension Plans

DB plans are increasingly being eliminated and replaced by DC plans, which are less costly and totally transfer the risk from the employer to the employee. DC plan-holders must make all of their own investment decisions. This is the opposite of DB plans, which are managed as pools and plan members have no say how they’re invested.

Few DC plan administrators provide advice, so you’re probably on your own. Unfortunately, few people know what they’re doing so they manage their DC plans poorly.

In her book, Money 101, Ellen Roseman provides the basic essentials of pension plans, as well as many other money topics. She advises that understanding your pension plan should start with a thorough read of your plan booklet. You know where it is, right?

“Your employer’s pension plan may be great, middling or not so good,” Roseman writes. “Bone up on your investment choices, if you have any to make.”

Your friendly financial planner, if you have one, should review your plan and educate you on what you need to know. I do this for my clients. Most financial advisors will, if they’re qualified.

Roseman also advises you to consider what pension plan, if any, a potential employer offers when considering a new job. “You don’t have to make it a deal breaker,” she writes. “You can accept a challenging, well-paid job with a rotten pension plan – or no plan at all. But when you’re offered similar jobs, you should gravitate to the one with the best pension plan and employee benefits.”

This seems like a no-brainer but I’ve seen people accept a job offer and check out the pension plan later. (While you’re at it, ask about group life and disability insurance, and the health and dental benefits.)

The right pension plan can set you up to retire in your 50s with an indexed pension for life, if you stay around long enough. Again, those are the DB plans – increasingly rare, remember. Even RBC, the country’s largest bank, wrapped up its DB plan a few years ago because of the high cost and risk.

Chances are your pension plan, if you have one at all, is a DC plan. If you’re uncomfortable managing your investments, good luck. Unfortunately, unless you’re lucky enough to grab a job with government or a large company, a DC plan is all you can look forward to. If you’re self-employed, that’s an entirely different topic.

If you’re in any of these categories, there are options. Self-employed individuals can set up their own employer savings plans.

“These folks,” Roseman writes, “may have to top up the pensions they get from government and an employer with their own retirement savings plan. That’s the role of the tax-sheltered RRSP.”

That’s the next chapter in Roseman’s book. Suffice to say that RRSPs are a great tool but most of us put far too little money into RRSPs to provide for the retirement of their dreams.